Expecting this market to maintain the 10-year average of approx. 28% per annum for the next few years is ambitious at best. Especially when you consider the current changing monetary policy and the cycle of EPS (Earnings Per Share) Growth rate.
Since the market low in March 2009, the S&P 500 index has been driving upwards in a strong trend that has only been surpassed by the Tech Boom of the 1990’s. In fact, the S&P 500 index has gained more than 300% to date in nearly 10 years.
For the average investor, they are quite oblivious to the Risks associated with a deep decline in the markets even despite the recent Global Financial Crisis (GFC) only 10 years ago. Continued booming growth in stocks has investors viewing the markets with an expectation of continued positive movements.
Gains in leading Tech companies such as FaceBook, Alphabet (Google), Apple, Tesla, Netflix and Amazon for example, have investors thinking this Bull market will never end.
But it will. Markets cannot sustain this level of growth indefinitely.
Market history has proven time and time again that a strong run up will be followed by a decline (sharply or otherwise). It is referred to as Overbought versus Oversold analysis.
Overbought versus Oversold
When stock prices get pushed too high, or into an overbought environment, “smart money” investors start to get nervous. For the average investor, they start getting nervous and begin selling their shares, but when there is no market to buy, prices start to fall.
Every major market correction (or crash), has needed a trigger. Something to change investor mindset from Fear Of Missing Out (FOMO) to uncertainty and inevitably panic. Be that from debt (GFC), commodity prices (Oil Crisis), Central Banks (Currency Crisis), or even military conflict (Gulf War).
So what we are truly on watch for right now is what will be that next catalyst for the markets to change – dramatically.
Will Economics cause a Bear market?
Let’s take a look at the current economic environment. We have an interesting picture, which must be considered without emotional attachment, but with a savvy outlook for how economies transition:
- Company profitability (Earnings Per Share) is starting to slow. Profits are peaking, which is typical towards the end of an economic cycle
- The Federal Reserve is tightening Monetary Policy. Interest Rates are at the start of a rate rising cycle. Typically to slow Inflation or to restrict credit/debt.
- Inflation has been slowly increasing. Hence the raising of Interest Rates. However, at 2.5% (at time of writing), this is still within the Fed’s management levels, and not a Doom and Gloom signal (yet).
- Unemployment is at long-term lows. Normally a very positive outcome for the economy.
All in all, the Economic picture isn’t bad!
Changes in Tax reform and International Trade are certainly 2 big topics (and beyond the scope of this short article) that could cause some panic amongst investors. But we are yet to see this reaction outside of the “realignment” (10% correction) earlier in the year, which really just came off the back of an Overbought market environment.
The “Market Trigger” for a Bearish shift beyond the current 10% correction might not present itself until after we have seen the markets move.
For this reason, my opinion is that the longer this market consolidates or even pushes higher, there is greater cause for adjusting your portfolio to become more defensive. None of us like giving back the money we have made from such a prosperous bull market, hence we need to be savvy with our portfolio management moving forward.
What can you do to make your Portfolio more Defensive?
- Reduce your exposure to Volatile/Small Cap stocks & Increase your exposure to Blue Chips stocks
- Reduce Stock exposure – increasing Bond/Treasury Bills
- Consider Hedging your portfolio downside risk using a longer dated Put option
- Decrease margin Risk (borrowed money for investing)
- Rotate out of Tech stocks and into Tech Exchange Traded Funds (ETF’s)
- Balance portfolio with ETF exposure over Stocks
- Slowly increase cash levels as stocks peak (and you take profit), or as prices change trend and you exit.
There are many other variations of action you can take that could warrant further investigation.
My key Trigger!
With the current market consolidation, the rising Inflationary environment (increasing interest rates), and uncertain global political environment, I believe the growth rate for stock prices is at a slowing point.
It won’t take a huge catalyst to incite fear amongst investors, triggering a panic that could trigger a further 10% decline in stocks. Hence the prudent move to go Defensive with investment portfolios.
Is this a Doom and Gloom outlook? No, but you don’t want to be the last person standing without a chair. Hence, you need to take action before something triggers a change in trend.
And besides, if you go a little more defensive now but the markets go up for another year, what is the worst case scenario? You’ve still made a return, albeit at a slower rate than previous years.
To me, it’s an obvious strategy choice in management.